A view on asset allocation is often rooted in an assessment of where we are in the cycle. Early in the cycle, valuations are cheap, policy accommodative and the economy has ample spare capacity to grow. It’s often a good time to take risk.
Conversely, late cycle is usually a good time to take chips off the table. When the economy is displaying signs of exuberance or overheating, higher interest rates usually put an end to the party.
It’s proving much harder to navigate markets today based on an assessment of the cycle. The map is far from clear. Unemployment rates – often a key navigation tool – are near record lows in most parts of the developed world, suggesting the economy is very late cycle. However, there are very few other signs of classic late-cycle economic exuberance. Neither business nor consumer spending looks toppy. Indeed, the US consumer is looking remarkably prudent: the savings rate, which often falls sharply late in the cycle, is pretty high (see below).
Household saving rates and inflation expectations
Household saving rates Market-based inflation expectations
% of disposable income %, 5y5y inflation swap
And inflation is certainly not suggesting the global economy has reached its limits. In fact, central banks are preoccupied with the idea that inflation remains too low and may be getting stuck. Rather than trying to tame the expansion, the primary focus for central banks is how to gee it up.
This makes it very hard to say confidently how much time is left on the economic clock.
A resolution in the US-China trade conflict, a Brexit solution, and an easing of tensions in Hong Kong, Chile and Turkey could fuel a turnaround in business sentiment and a reacceleration in activity in 2020. Against a backdrop of muted inflation, interest rates could stay low. This would be a good environment for risk assets.
But it is more likely, in our view, that geopolitical risk will linger. We think the trade conflict is unlikely to be fully resolved. Surveys suggest the US electorate believes the president is right to address unfair trade practices, while on certain areas of the disagreement – such as China’s state-led subsidies for its tech sector – there is seemingly no common ground. China believes in industrial policy, the US does not.
The US administration does seem to appreciate that it needs to get the balance right between keeping the agenda alive and not damaging the US expansion, hence the recent more conciliatory tones. We’ll see in the coming months whether this more measured approach does much to boost corporate sentiment. Companies have been spooked, and are likely to remain reluctant to invest, which will limit the extent to which manufacturing bounces back through the course of 2020. This reluctance appears to be filtering into hiring intentions.
If geopolitical tensions linger but don’t re-escalate, we should be facing a slowing rather than a stalling economy. But that is a big ‘if’. Our newly established health monitor (below chart) highlights the key indicators of US economic activity and will help us track the risks in the coming months.
US economic health monitor
Percentile rank relative to historic data since 1990